NY futures added to their recent gains this week, with May advancing another 101 points to close at 62.81 cents.

The May contract, which is now the lead month with the highest open interest, posted its best close in over three months today, extending the current rally to nearly 500 points. The market was able to shrug off some negative news on its way to these new highs, such as a less than inspiring WASDE report, news of a large Turkish mill facing financial difficulties and a disappointing US export sales report.

US export sales cooled off considerably last week, with net sales of Upland and Pima cotton amounting to just 78’400 running bales. On a positive note there were still 18 markets participating, resulting in gross new sales of 176’000 running bales, but a large cancellation in Turkey of nearly 100’000 bales dampened the mood. Nevertheless, total commitments have now reached just under 10.0 million statistical bales, whereof 3.7 million bales have so far been exported.

The latest USDA supply/demand report painted an all-to-familiar picture, with China getting more bearish, the rest-of-the-world (ROW) holding about steady and the US seeing its balance sheet tightening considerably. Ending stocks in China are projected to increase by another 1.3 million bales to a record 64.5 million bales, while ROW inventories were taken down 0.1 million bales to 45.4 million bales. Added together global ending stocks are now expected to reach nearly 110 million bales or about the level of global mill use in an entire season!

However, while China continues to have way too much cotton on hand, the US has already committed most of its supply, with nearly six months left in the marketing year. Total supplies amounted to 18.5 million statistical bales this season, of which around 13.6 million bales have so far been committed to foreign and domestic buyers for shipments up to July. Additionally domestic mills will require around 1.0 million bales to bridge them over to new crop and then there are already some 0.6 million bales in export commitments for shipment July onwards on the books.

This leaves around 3.3 million statistical bales available, of which 0.5 million are Pima, which reduces the amount of available Upland cotton to less than three million bales. It should therefore come as no surprise that the US is finally starting to ration its remaining supply by trending higher.

Based on the just released NCC plantings estimate of just 9.1 million acres of Upland (9.4 million acres including Pima), the US supply situation is likely to remain relatively tight all the way through the 2015/16 season. If we were to add a potential Upland crop of 13.7 million bales for next season to the 2.8 million bales that remain from the current crop, then total supply of Upland cotton would amount to no more than 16.5 million bales over the next 20 months, which equates to just 0.83 million bales a month between now and October 2016. Considering that most origins across the globe are also going to see planting reductions and that Australian cotton is finding willing buyers at a basis of over 2000 ‘on’ for several crop years ahead, we currently cannot envision a scenario under which the basis level for machine-picked, contamination free high grades would come under a lot of pressure. Brazil, which also fits into this quality segment, is expected to export between 3.2 and 3.5 million statistical bales in 2015 and 2016, but that won’t be enough to alter the tight supply situation for machine-picked cotton on a global scale.

Turning to consumption, we find it rather odd that the USDA keeps reducing global mill use at a time when falling crude oil prices put more money in consumers’ pockets. Since November the USDA has lowered global mill use by 2.65 million bales, from 113.85 to 111.25 million bales. Most of this reduction has occurred in China, where mill use has been lowered by 2.0 million bales, from 37.5 to 35.5 million bales.

While we don’t disagree that China’s mill use may be in decline, we feel that other origins are picking up the slack to a greater degree that the USDA is giving them credit for. With Chinese prices still some 30-35 cents above the A-index and with fewer cotton imports available this season, some production has shifted to places like Vietnam, where mill use has been growing by leaps and bounds. Also, China’s yarn imports are currently at a record, averaging around 200’000 tons for December and January, while Indian yarn exports of 125’000 tons in November were quite a bit stronger than a year earlier. We therefore interpret this as a shift in mill use from one place to another, rather than a loss in overall output.

According to the latest CFTC report as of February 3, speculators bought nearly 2.6 million bales net during that week, while the trade sold 2.9 million bales net. Instead of reducing overall open interest by any meaningful amount, speculators simply swapped their short positions with the trade. As a result open interest in futures and options positions went down by just 0.5 million bales, from 20.6 to 20.1 million bales.

Last Friday’s option expiration and this week’s index fund roll should have reduced these positions further, but judging by this morning’s open interest in futures it was still quite high at 19.3 million bales, which means that the situation has not yet been defused.

So where do we go from here? The potential for a squeeze remains, because there is still a large contingent of shorts confronted with a tight US cash market situation. US basis levels remain high and the certified stock has dropped below 10’000 bales as of this writing.

Spec shorts seem to make an effort to get out of harm’s way, but we don’t quite understand why all these outright trade shorts are still hanging around (12.0 million bales as of Feb 3). Since the US has only about three million bales of Upland cotton left to protect in current crop, the additional shorts must either be against unsold foreign growths, the 4.1 million bales in unfixed on-call sales in March, May and July, and to a smaller degree new crop. To us this all adds up to a lot of buying pressure over the coming months, which should keep the current up move going.